Founders may inadvertently give VCs too much power to block IPOs
Although some investors Lamenting loudly that the IPO window cannot be closed forever, other venture capital firms themselves are actually part of the problem.
Eric Weiner, a partner at Lowenstein Sandler, told TechCrunch that many standard venture capital deal terms allow investors to block an IPO or acquisition if they believe the timing or price is not right. While it’s relatively uncommon for investors to block an IPO with direct language, though he’s seen it happen in the past, there are plenty of equity deal terms that essentially allow investors holding preferred stock to do the same thing, he added.
Investors who hold preferred stock have greater power than those who hold common stock, giving them a voice and often voting rights when a company engages in activities that dilute their stock or convert it into common stock. The IPO process accomplishes both of these things simultaneously. “It’s not easy to go public,” Weiner said. “A lot of things have to be aligned.”
Ryan Hinkle, managing director at Insight Partners, said that before a company goes public, investors who own preferred shares — especially those who set the terms in a recent funding round — must want an initial public offering (IPO). In a good market, investors and founders may agree on the right time to go public. Today, founders may agree to exit at a price lower than the startup’s last valuation. But their investors must also agree.
“Any preference that the stock had is gone, you no longer have a 1x liquidation preference, and when you convert to common stock, you don’t have board designation rights,” Hinkle said of what happens to venture capital stocks after an IPO. When to say. “The last round, if you don’t get over that number, the last investor basically needs to do an IPO or it’s not going to happen.”
A 1x liquidation preference means that an investor has priority in repaying invested capital upon acquisition before any other investor. This is a common term that refers to late-stage investors agreeing to pay a higher price for their shares to increase the valuation of a new startup. The term preferred by more investors (especially early stage investors) is “pari passu” – giving equal shares to all shareholders.
For many new startups raising funds in 2021, this increased entitlement may be a roadblock. When late-stage startups raised money at sky-high valuations in 2021, they may not have realized how much power they would give to late-stage investors if the market cooled, which it did.
“People confuse the right with God-given rights,” Schinkel said. “We have rights to life, liberty and the pursuit of happiness. We don’t have rights up and to the right.”
Alan Vaksman, founding partner at Launchbay Capital, agrees. He added that there is always more friction between investors and startups over IPO decisions than investors are willing to admit. It’s not all coming from a negative or selfish place, either, he added. These investors have a fiduciary duty to their limited partners, requiring them to make the wisest financial decisions that will generate the highest returns for their investors. It’s not wise to push a company toward an IPO when it might return more capital while it waits.
Public markets have also changed over the past few years. Schinkel said companies traditionally should have eight quarters of strong growth and metrics before entering the public markets. While the company could get away with this in 2020 and 2021, it can’t now. Waxman agreed.
“The public markets are less concerned about your growth and more about pure financial health, good profitability and margins,” Waxman said.
In addition, the rise and maturity of secondary markets, where private shareholders can sell shares in company-approved transactions, also plays an important role in venture capital. Secondary markets allow them to access liquidity when needed, rather than forcing startups with depressed valuations to go public.
Founders dealing with VCs may drag their feet, which may cause tension in the boardroom but may lead to better outcomes for the startup, its VC backers, and the VC’s underlying limited partners.
“While I would have guessed a year ago that we would be closer to normal than we are now, SVB has put tremendous pressure on the world, and with rising tensions in the Middle East, these uncertain times have brought fear, suspicion and… Risk.” “I don’t expect a boom in IPOs this year.”
